I am Director of Entitlement and Budget Policy for the Heartland Institute, Senior Advisor for Entitlement Reform and Budget Policy at the National Tax Limitation Foundation, General Counsel for the American Civil Rights Union, and Senior Fellow at the National Center for Policy Analysis. I served in the White House Office of Policy Development under President Reagan, and as Associate Deputy Attorney General of the United States under President George H.W. Bush. I am a graduate of Harvard College and Harvard Law School, and the author most recently of America's Ticking Bankruptcy Bomb (New York: Harper Collins, 2011).
I write about new, cutting edge ideas regarding public policy, particularly concerning economics.

Tax Reform: Restoring Booming Economic Growth, and the American Dream

Before America dropped off the gold standard in 1971, long term real economic growth averaged nearly 4%. At that long term growth rate, our economic production would more than double after 20 years. After 30 years, GDP would more than triple. After 40 years, a generation, total U.S. economic output would nearly quadruple.

Nothing could be more important for the middle class, working people, and the poor, then reestablishing that long term rate of economic growth. Yet, Obama and his economic policies have America limping along at barely half that. That is because all of Obama’s economic policies are consistently anti-growth, or the opposite of everything that would be pro-growth, as discussed below.

But Obama and his economic policies have been even worse for America than that. That is because the history of the American economy is, the worse the recession, the stronger the recovery, as the economy has to grow faster than average for a while, to catch up to the long term economic growth trendline. President Reagan’s recession ended in November, 1982. By 1984, real economic growth was booming by 6.8%, the highest in 50 years. Over the next 7 years after the end of Reagan’s recession in 1982, the huge American economy, the largest in the world by far at the time, grew by almost one-third, the equivalent of adding the entire economy of West Germany, the third largest in the world at the time, to the U.S. economy. Nearly 20 million new jobs were created during those 7 years, increasing U.S. civilian employment by almost 20%.

Moreover, since the Great Depression, America suffered 11 previous recessions before this last one, which started in December, 2007. Those 11 previous recessions lasted an average of 10 months, with the longest previously lasting 16 months. Obama was sworn into office in the 13th month of the recession, in January, 2009. That means based on the historical record the recession was about to end in a few months, followed by a booming recovery, with faster than average growth to restore the American economy to the long term economic growth trendline. Consequently, Obama was poised upon entering office to get the political credit for the booming economy recovering from the steepest recession since the Great Depression, just based on the historical record of the American economy going back almost three quarters of a century.

Indeed, the recession did end just a few months after that, in June, 2009, according to the National Bureau of Economic Research. But Obama had already by then begun his fundamental transformation of America. So there never was any booming economic recovery. Instead, what America got was the worst recovery from a recession since the Great Depression, based on economic growth, jobs, wages, income, poverty, even inequality, which of course has actually gotten worse under Obama, with no sustained economic growth sufficient to raise the wages and incomes of the middle class, the working class, and the poor. No wonder polls now show Americans identifying Obama as the worst President since World War II.

That is the only valid way of measuring the performance of the American economy under Obama, by comparing it to other recoveries from other recessions under prior Presidents. Not by comparing the recovery to the worst depths of the recession, as the Obama apology cult does. Of course the recovery is better than the recession. It always is, by definition. Nor is there any good excuse for claiming that this recession was somehow different from all previous recessions. Recessions and recoveries have been going on for centuries, and are well defined.

We know how to restore booming economic growth to the American economy, based on the historical record and what has worked before, and the timeless principles and logic of economics, which provided the foundation for Reaganomics. I noted last week how the authors of the book Room to Grow had overlooked the central issue on which conservatives and Republicans need to campaign in upcoming elections: a promising agenda to restore traditional, booming, American economic growth. I promised to fill that gap in following columns, which I start below.

The first component of a comprehensive plan to restore booming economic growth is tax reform. The key to understanding the impact of taxes on the economy is to focus on tax rates, particularly marginal tax rates, which is the tax rate that applies to the last dollar earned. The tax rate determines how much the producer is allowed to keep out of what he or she produces. For example, at a 25% tax rate, the producer keeps three-fourths of his production. If that rate is increased to 50%, the producer keeps only half of what he produces, reducing his reward for production and output by one-third. Incentives are consequently slashed for productive activity, such as savings, investment, work, business expansion, business creation, job creation, and entrepreneurship. The result is fewer jobs, lower wages, and slower economic growth, or even economic downturn.

In contrast, if the tax rate is reduced from 50% to 25%, what producers are allowed to keep from their production increases from one-half to three-fourths, increasing the reward for production and output by one-half. That sharply increases incentives for all of the above productive activities, resulting in more of them, and more jobs, higher wages, and faster economic growth.

Moreover, these incentives do not just expand or contract the economy by the amount of any tax cut or tax increase. For example, a tax cut of $100 billion involving reduced tax rates does not just affect the economy by $100 billion. The lower tax rates affect every dollar and every economic decision throughout the economy. That is because every economic decision is based on the new lower tax rates. Indeed, the new lower tax rates affect every dollar, or unit of currency, and every economic decision throughout the whole world regarding whether to invest in America, start or expand businesses here, create jobs here, even work here, because all these decisions will be based on the new lower tax rates. Tax rate increases have just the opposite effect on every dollar and economic decision throughout the economy and the world.

In addition, marginal tax rates do not just affect the incentives of those to which the rates currently apply. They also affect those to which the rates may apply in the future. For example, consider a small business owner. If he invests more capital in the business to expand production, or hires more workers to increase output, that may result in higher net taxable income. It is the tax rate at that higher income level, not at his current income level, that will determine whether he undertakes the capital investment, or hires more workers.

Multiple Taxation of Capital

These incentive effects are compounded in our tax system through the multiple taxation of capital. Capital income is taxed not once, but several times in federal and state tax codes. For example, consider a saver who invests a dollar in a corporate enterprise. Any dollar that corporation earns is taxed at the corporate income tax rate, totaling roughly 40% in America on average now, counting federal and state corporate income taxes. If the remainder of that dollar is paid to the investor in dividends, then it is taxed again through the individual income tax at the dividends tax rate. With President Obama increasing the dividends tax rate from 15% to 23.4%, applying that 23.4% tax rate to the 60 cents remaining after paying the corporate income tax leaves just 46 cents for the investor out of the original dollar earned.

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